How You Process Financial Decisions Can Make All the DifferenceSubmitted by BCR Wealth Strategies on May 17th, 2021
When a financial decision/opportunity is in front of us we typically fall into one of two thought processes to make our decision. While neither is right or wrong, not understanding the impact of the other can cause us to miss the full impact, causing unintended consequences.
- Cash flow thought process- With the cash flow thought process you look at how the income and expenses created from the decision impact your monthly cash flow. If it increases your cash flow great and if it decreases your cash flow you consider how much you expect it to increase your quality of life. People that focus on cash flow tend to be more focused on the here and now, “YOLO, I would rather have it today because I don’t know what tomorrow brings.”
- Net worth thought process-With the net worth thought process you look at the growth or reduction to the assets you own and what you will have down the road. If you will have more towards goals like retirement great and if it decreases what you will have you consider how much to expect it to increase your quality of life. People that focus on net worth tend to be more focused on the long-term, “I would rather have 2 a year from now than 1 today.”
To understand unintended consequences let me tell you a couple stories.
Adam focuses on the cash flow thought process. After college, Adam maximized the lifestyle he could achieve with his income, realizing that he would worry about things like retirement as he got older. Adam in now 40 and he realizes he needs to start saving but he is having trouble figuring out where he can cut to find savings.
Great news comes one day with a phone call from his favorite car dealership. Adam typically buys a new car from them every 8 years. The salesman tells him that they have too many of the brand-new version of his four-year-old car. The salesman informs him that they want to get rid of them so bad that he can roll his remaining debt on the current car into a new one and still have payments $200 less than he currently pays. Adam figured this was exactly what he was looking for as he needed another $100 for his sons after school activities, could save another $100 into his retirement account at work, and gets a brand-new car to show off.
With Adam’s sole focus being on cash flow he missed the long-term impact. Adam only had 11 months of payments left on his 4-year-old car and the salesman cleverly put him into an 84-month loan to get the payments down. Where Adam would have had a lot more to save in short order with no payments until he actually needed a new car, this decision burdens him with debt close to the time before he would get a new car again.
Rachel was hyper focused on saving for the future from the day she graduated. She maxes out her retirement accounts and invests in opportunities that have potentially high returns over the long-term but do not offer liquidity if needed quickly. Now 40 as well, her life has grown so that her family, lifestyle, and expenses have crept up. She is still saving at a pace that she will be able to retire early if she wants but her monthly cash flow is stressed so that unexpected expenses go on a credit card.
Rachel got her annual bonus and while she had planned to pay down the credit card an opportunity popped up instead. An amazing deal on a rental property provided she uses the bonus for a down payment. Her pro forma based on the expected monthly rent covers the expenses including the mortgage at a 20-year amortization plus $10 per month. She figures the tenant is paying off the mortgage so that she can have income or sell it debt free in the future.
In Rachel’s rush to increase her net worth, she is not considering an exit strategy if she needs the money, how she would cover the expense between tenants, and how to pay for unexpected damage. While this appears to have a good long-term impact, it has a high probability of stressing her cash flow and causing her to go into even more credit card debt.
Like so many both Adam and Rachel are so focused on their primary financial process that they do not give credit to the unexpected consequences. When you make a decision, you will naturally focus on one process or the other but those with the best all around finances take time to consider both before making a decision. While it may be a clear win with one thought process both Adam and Rachel should be walking away based on the other.